NAR Housing Affordability Index is Worthless
The monthly update to the NAR Housing Affordability Index gets released Thursday morning (August 14), as well as the Quarterly Housing Affordability Index for First-time Buyers.
Some people seem to think this index is meaningful. Over the past month, I have received numerous emails explaining to me how “affordable” Housing has become, most notably via this index.
To determine as to whether that was true or not, we looked more closely into the Housing Affordability Index (link, or AFFDCMOM on your Bloomberg terminal) — its methodology, what it contains and in particular, what it omits.
Our conclusion? The index as presently constructed is utterly worthless. It provides little or no insight into how affordable US Housing actually is. Further, what is omitted from the index is especially relevant to the problems occurring in the housing market today. The Index fails to account for — or even recognize — any of the out of the ordinary circumstances that are currently bedeviling the Hosuing market.
Consider the red line in the nearby chart (click for larger graphic). That is the NAR HAI rating of “100″ — what the NAR states as their baseline measure of affordability. As hard as this might be to imagine, it shows that over the course of the biggest run up in housing prices in American history, the Index remained perfectly affordable. Except for one monthly reading of 99.55 in late 2005 — a smidge below 100 — housing never dipped into the level of unaffordable over the entire giant housing boom.
This is mind bogglingly astonishing. If the affordability index failed to show housing was unaffordable during 2005-06, when would it ever show that?
Given this rather extremely dubious conclusion, we simply had to look at how the Index was composed, to see if we can figure out where it went so terribly astray. We conclude that the index is overly simple, that it fails to include many key factors of the current financial crisis. The index ignores factors like family savings rates, available cash assets, consumer credit, indebtedness, credit servicing obligations inflation, income gains, and mortgage availability.
These are crucial factors impacting the current housing situation. Hence, why today’s missive will caution you against putting any weight whatsoever on the NAR Housing Affordability Index. It is, to be blunt, without any value at all.
Let’s take a closer look at what goes into it, and what’s missing, so you might better understand its weaknesses and flaws.
The source: First, I begin with the assumption that readers are aware of the National Association of Realtors abysmal track record. Throughout the entire downturn, they have acted not as objective purveyors of data, but as cheerleaders and spin doctors. (See Tracking NAR Spin, or Worst. Forecasters. Ever? or NAR and Housing Forecasts for the ugly details). The bottom line is that one should treat any analysis from the NAR warily, and look very hard at their data and forecasts.
Note: This is not a mere ad hominem attack, but rather, it is simply a case of accountability for the reports and commentaries of the past 3 years. They have been wildly wrong for an extensive period of time.
Onto the Index: The NAR Housing Affordability Index is quite simple in its construction: The real estate broker’s association looks at whether the
median family income “qualifies” for the median house price using
prevailing interest rates. Qualifying ratio of 25% of the median income
has to cover 100% of the monthly mortgage P&I, which is 80% of the home’s purchase price.
Take the median home price as calculated by the NAR. Use the prevailing interest rates, as determined by via Federal Housing Finance Board. Then calculate how much principle and interest of a monthly mortgage for 80% of that property value would be. Lastly, take the median national income (via U.S. Bureau of the Census).
A value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. 120 = 120% of the income necessary, 80 = 80% of the income necessary. (See: Methodology for the Housing Affordability Index).
Voila! Affordability Index!
Where things get interesting is when we look into some of the assumptions of the index, and what was omitted from consideration.
Consider the omissions:
